Why I Gave Up Trying To Short Canada’s Obvious Real Estate Bubble

The year was 2013. Nelson was still a chip guy, instead of being scared to go outside in the rain. Nelson was single, because, well, throughout his life at that point it would have been a pretty good guess. And Nelson wrote this massively long piece outlining why he thought Canada was in a giant real estate bubble. To this day it remains one of my more popular posts, at least judging from the number of you guys who left a comment.

But I didn’t just go as far as predicting the demise of your uncle Larry’s home equity. I went a step further, buying long-term puts on some of Canada’s largest banks, including Royal Bank, TD, BMO, and National. At the time, they represented about 20% of my stock market portfolio (not my entire portfolio, which is still a real estate and private mortgage heavy). I wasn’t sure when this was going to happen, but I was convinced the banks would be in the crosshairs when the proverbial you know what hit the fan. They weren’t about to go bankrupt, but I could see shares in each falling 40-50%.

Remember, investor sentiment is extremely important during times of duress. If investors go from loving the banks to “OMG IT’S JUST LIKE THE U.S. IN 2008 STOCK UP ON CANNED GOODS AND BULLETS,” that affects the banks’ share price. The market isn’t efficient, so my thoughts were that banks would get oversold as the media continued to cover the housing meltdown.

Of course, none of this happened. The market chugged along, the banks have delivered record profits to shareholders (by releasing loan loss provisions to make things look better), and I slowly watched as my “short Canada” thesis lost me more and more money.

I first thought about closing the position in December, when I was looking at harvesting tax losses for 2013, but didn’t do it. I just couldn’t pull the plug on it. I got emotionally involved, which was a mistake. I didn’t want to be proven wrong.

Finally, in January, after watching each of the banks hit a fresh 52-week high I couldn’t take it anymore. I liquidated the entire position over the course of a couple days. Let’s not talk about how much I lost, but let’s just say it wasn’t pretty. I did myself a favor by sticking to the options with a higher strike price, which limited my losses (and my potential upside if I had been right), and my overexposure to real estate means my stock market account still isn’t anywhere near 50% of my net worth. So it could have been worse.

What went wrong?

The first thing I did wrong was start to enter this trade when a lot of other people were thinking the same thing. They bid the price of the options up as the price of the banks declined. Thus I was getting in at the worst possible time.

The key to doing something like this is to get in when nobody else is thinking about it. I got impatient when I started watching bank shares go down and decided I needed to be there or else it would be too late. Patience is a virtue, as I’ve said before, and I didn’t practice it.

At the time it seemed like interest rates were on the cusp of going up, which I thought just might be the stimulus needed to start the whole dismantling of the market. After a few months all the interest sensitive stocks started to go back up, and a year later we’re still sitting on ultra low interest rates.

As time went on and real estate markets across the country started coming out with good sales numbers, I knew that 2014 wouldn’t be the year it all collapsed. As many of the commenters pointed out in the original piece, the timing was the most difficult part of the trade. If the timing was right I would have made a lot of money. It became obvious in the latter months of 2013 that the market would remain at least decent until 2014. And so far it’s turned out that way.

I still maintain Canada’s real estate bubble will pop in a very messy way. I’ve even thought about going after the 2017 options because they’re at a little more attractive levels then when I bought originally, but those thoughts quickly went away. I’m content to walk away humbled.

You win, housing bulls. You have slain me, and I won’t bet against you again. Feel free to buy all the overpriced Toronto and Vancouver houses. Nelly won’t stop you.

9 Comments

We’ve all made mistakes like that 🙂 I tried shorting the overall stock market once and lost $2K lol. In terms of banks I’ve always assumed they would actually be more profitable in an increasing interest rate environment because the fixed income portion of their portfolios would earn more money, net of delinquencies.

As long as interest rates are next to nothing people feel brave and buy homes. From what I heard on the radio today it sounds like any significant rise is still years away. Can the US afford a rate rise with their ballooning debt? I think they will artificially hold it down (and with it Canada’s) as long as they can.